Eight years after The Wall Street Reform and Consumer Protection Act was signed, there are still a number of analysts and lobbyists who keep blaming this landmark financial reform legislation for alleged slowdowns in the US economy. In a recent piece entitled Trump Poised to Take Control of the Federal Reserve, bank analyst Dick Bove stated that Dodd-Frank rules “have meaningfully slowed bank investments in the economy (the Volcker Rule) and they have had a crippling effect on bank lending in the housing markets.” First, the Volcker Rule in no way has slowed bank investments in the economy. The purpose of the first part of the Volcker Rule, which has been in effect since 2015, is to curb banks’ speculating when they trade securities and derivatives. The second part of the Volcker Rule, which was postponed several times, is intended to limit how much banks can invest in private equity, hedge funds, and special purpose vehicles. Given that the recession ended in 2009, before Dodd-Frank was even signed the summer of 2010, and that GDP has been rising every quarter consecutively since the second quarter of 2014, it is difficult to see how the Volcker Rule has slowed banks’ or any other corporations’ investments in the economy.
Secondly, while mortgage indebtedness is not yet at its peak level that it was the 3rd quarter of 2008, mortgage debt as seen in Federal Reserve data has been rising since the third quarter of 2013. Bove provided no proof that Dodd-Frank is the cause of fewer people buying homes or applying for mortgages. Because banks’ due diligence of mortgage borrowers had been so poor and in fact a main contributor to the 2007-2008 financial crisis, banks began to be more careful about their lending standards for all types of loans during and immediately after the crisis. The decrease in mortgage lending happened during the crisis almost two years before Dodd-Frank was even signed.
The Federal Reserve’s recently released Quarterly Report on Household Debt and Credit stated that second quarter 2018 “Mortgage balances, the largest component of consumer debt, reached $9.0 trillion, an increase of $60 billion from the first quarter.” It is important to remember that the pernicious effect of the financial crisis, such as high levels of unemployment that finally began to decrease pretty consistently since mid-2011, were a major deterrent to home buying. Additionally, real wages remain stagnant for millions of Americans, and the rising costs of education, housing, and other goods has slowed down millennials, in particular, from buying houses. Important to note here as well is that while Mr. Bove blames Dodd-Frank for allegedly hampering bank mortgage lending, he does not mention at all that the mortgage lending landscape has changed a lot since the crisis. Non-bank lenders now provide a lot of competition to banks in mortgage lending.
If it were true that Dodd-Frank hampered mortgage lending, then it would stand to reason that other debt levels should be declining. The opposite has been happening. According to the Federal Reserve, “Aggregate household debt balances increased in the second quarter of 2018 for the 16th consecutive quarter, and are now $618 billion higher than the previous (2008Q3) peak of $12.68 trillion. As of June 30, 2018, total household indebtedness was $13.29 trillion, an $82 billion (0.6%) increase from the first quarter of 2018. Overall household debt is now 19.2% above the 2013Q2 trough.”
Also, important to note is that not only have mortgage debt, car loans, credit cards, and student loans been rising, so has corporate debt. As Federal Reserve Bank of St. Louis data show, loans to US corporations are at historic highs. In fact, corporate debt to GDP is back to the levels it was as its last peak in 2008. Particularly in a rising interest rate environment, we should be concerned that many of these corporate loans may not be of great credit quality given banks’ declining due diligence standards.
If it were true that Dodd-Frank has been so restrictive, banks would not be as profitable as they have been for several quarters. In fact, earnings have been rising most quarters since the second quarter of 2016 as shown in Federal Deposit Insurance Corporations (FDIC) graphs. In the first quarter of 2018, the FDIC announced that banks’ quarterly earnings had risen 27.5% from the same period in 2017 to $56 billion in net income. Moreover, according to Ms. Rita Sahu, Credit Officer at Moody’s Investors Service “Seventeen of 25 banks, or 68%, will return more than 100% of their earnings, based on the four quarters of net income through the first quarter of this year.” If bank regulations were so restrictive, it would not be possible for banks to pay such a level of dividends and to do share buybacks.
While Dodd-Frank may be an imperfect piece of legislation, as all others are, it is important to stop blaming this legislation for things that it did not cause. If anything, Americans should worry that with recent weakening of this legislation, banks might go back to their lax risk management of the early and mid-2000s that caused the last crisis.
